Sample of Sellside Global Strategy Research Report

During large scale events such as the ongoing situation that started in Tunisia and has moved on the rest of the Middle East and North Africa, sell side institutions may publish a combined research report from multiple departments.  This is the case with the Strategy Snapshot from Credit Suisse.  Here the fixed income division writes about commodities, foreign exchange, mortgages and emerging markets.  The main themes are:

• If oil prices reach $150/barrel or gas prices reach $4.50/gallon, then they will negatively affect any economic recovery
• Italy will be most affected by Libya's turmoil but should be able to obtain energy from other sources
• Any Algerian trouble will affect Spain and Italy
• Major concerns of the US markets are Government Sponsored Enterprises reform, debt ceiling for the federal government and 2012 US budget
• Recommended emerging markets currencies to invest in are the Mexican peso, South Korean won, Chinese renminbi, Indonesian rupiah, Israeli shekel, Polish zloty, South African rand and Turkish lira.

Studies in Client Profitability

We have reviewed the broker vote and the main factors that contribute to it.  The next logical step is to analyze them and determine if the investment bank is receiving a good return on its allocation in resources.  It's a simple revenues versus expenses calculation.  The art is in determining what the expenses are and how to weight them.  What services are the most important and bring the most value to the buy side?  How much does each service cost?

Within the financial services industry, the most expensive costs are people's time.  For the main roles that interact with the buy side, banks would measure:

Research Analyst - 1x1 meetings, group meetings, field trips, projects/special reports, 1x1 calls, conference calls, entertainment
Research Sales - calls/time spent on client, entertainment
Salestrader - calls/time spent on client, entertainment

For Corporate Access, the statistics would include 1x1 meetings, 2x1/3x1 meetings, group meetings, field trips, presentations, conference calls, special events and entertainment.

In addition to the basic profit/loss analysis, there are scenarios run to estimate revenues if the resource allocation changes.  If a fund is given more meetings, what is the upside in revenue?  What is the downside in revenue if resources are cut?  How should we approach a client who is not giving the firm enough revenues to merit the resources that are given to them?  Here is where senior management needs to make hard decisions.  This is usually the province of a relationship manager for large accounts and sales management for others.  We will discuss the role of the relationship manager at a later time.

Reasons the Sell Side Would Vote for an Analyst

Each sell side voter and firm has its own investing philosophy.  Naturally, during voting season, they have different reasons for giving an analyst a vote.  These may be:
1.  Making a good call for buying or selling a stock
2.  Having insights into their industry or stocks
3.  Taking the trouble to meet with them personally (This applies especially for clients not in New York, Boston, California or London.)
4.  Having an interesting/fresh investment thesis
5.  Sponsoring access with corporate management via a conference, field trip or roadshow

Effect of the Technology Bubble on the Broker Vote

In the previous article, there was a short summary on the analyst level detail of the broker vote.  During the technology bubble in the late 1990's, there was a distortion in the vote.  At that time, the analysts covering the technology (especially Internet) sector received an increased number of votes at the investment banks.  This was an attempt to curry favor with the analyst in hopes of getting an allocation to a hot/oversubscribed IPO.  As with many situations in investment banking, this was unspoken.  On the whole, an analyst of the lead underwriter of the IPO would have a favorable reputation and the comment would be:  "He/she gives valuable insights."

Broker Votes for Research Analysts

Investment Banks are ranked by buy side firms during the broker vote process.  There are additional levels of detail that emanate from this vote.  Some firms also rank coverage by geographic region or country, sector or industry and individual analyst.  One of the measurements for research analysts is the broker vote.  Here is where the subjective/objective line can be crossed.  The fund managers and buy side analysts, after the initial rank, are asked to give details of who has helped them during the voting period.  This may be because of a timely stock call (buy or sell) or special insights or historical relationship.  The analysts are ranked by how many firms have voted for them.  This is done twice a year.

There are about 150-200 votes collected from buy side firms at any given time.  The top analysts generally garner votes from about 120 firms as not all buy side firms are interested in all sectors/industries.  There are also firms that refuse to give any details about research analysts.

Institutional Investors Magazine's Research Analyst Survey

One of the factors for measuring sell side analysts' performance in an investment bank is the Institutional Investors Magazine survey.  To sum up, the magazine has regional lists of the largest mutual funds, pension funds, endowments, etc.  Hedge funds have their own separate list.  They are known as the Institutional Investor 300 or Hedge Fund 100 lists and are ranked by the number of assets under management (in descending order).  Every year, questionnaires are sent to the buy side analysts asking them which sell side analysts have been the most effective.  The results are compiled and the top three research analysts of each industry covered are named as part of the All-America Research Team (in the US).  The names are reported in Institutional Investor.  Also mentioned are runners-up/up and comers.

There is an excellent article at briefing.com's Learning Center.  It is targeted to inform an individual investor about the process.  An important point is that an analyst's performance and compensation can be affected by this vote.

The goals in the survey are different based on the business models of the investment banks.  Bulge Bracket firms may try to be Top 3 in all industries and regions.  A boutique bank may desire to be top 3 in a particular sector.  One large firm had developed a strategy where they would have a limited focus.  They would be top 3 in the industries that had the most traded securities.  Quite simply, the stocks that generate the most commissions.  Another business strategy was to de-emphasize the regional ranking.  The firm wanted to target the firms that generate the most trading revenue - hedge funds.  Since they do not have the asset base of a Vanguard, Black Rock or Fidelity, their votes are usually watered down.  Institutional Investor's survey is weighted by assets under management.

A Day in the Life of a Research Analyst

Research analysts have less predictable days than either a research salesperson or salestrader. Their workday is somewhat less tied down to the market's trading hours. They are the experts of an industry or group of companies. Any news that must be incorporated into their models can arrive at any hour of the day. When an analyst has any breaking news, they want to be on the 7:30 morning call. When they are scheduled, they can be found in the office at 6-6:30; preparing for the meeting. At the call, they will present their thesis and answer any questions from the sales force. After the call, they will call their most important buy side clients while the research salespeople are calling theirs. If a particular client is interested in their viewpoint, they will ask to speak to the analyst. A highly regarded and ranked analyst can move the stock price.

Other days, the analyst has plenty of duties to occupy their time. There are financial models to be updated, clients to be called, research and marketing to be done. Analysts have 2 different client universes: buy side and corporate clients. The buy side includes the investors of the securities covered by the analyst. Corporate clients are the companies covered with the analyst. They speak with corporates to keep abreast of any industry news. Analysts also speak with third party sources such as suppliers and customers of the company, journalists and other industry experts.

Analysts also go on marketing trips. They talk to buy side clients about their research ideas. They may visit 4 cities in 5 days and have 15 meetings during the trip. This is arranged by a special analyst marketing group that parallels what corporate access does for company management.

An analyst's performance is measured by how the perform on the:

• Broker vote
• Rating by Research Sales
• Institutional Investor (II) ranking
• Greenwich ranking

Institutional Investor is a famous publication that has "All-Star teams" for each industry. It lists the top 3 analysts annually and has an up-and-coming team for promising analysts. The article is printed in 1 of II's magazines. Greenwich Associates has an annually survey that focuses on the qualitative rankings of the sell side analyst. In this survey, questionnaires are sent to be filled out by the largest buy side firms. The answers are analyzed by Greenwich and results are sold to the sell side.

Sometimes, they are also rated on the trading commissions for the stocks that they cover. This can be unreliable if they cover thinly traded securities.

You may be asking, "What about the accuracy of their recommendations?" Let me reiterate. The buy side is not solely interested on whether a stock is a buy, hold or sell. They are interested in the analyst's thought process and story.

Serving the Buy Side

Research, Sales and Trading

The main elements of the broker vote revolve around research and best execution. To better understand this dynamic, look at the traditional roles on the sell and buy sides and their lines of communication. On the sell side, there are four main actors: research analysts, research salespeople, salestraders and position traders. Their counterparts at the buy side are research analysts, portfolio managers (PMs) and salestraders.

Sell side research analysts are the idea generators for an investment bank. They follow a sector or industry and get to know the companies intimately through analyzing financial statements, talking to the company's officers, following industry news and speaking to suppliers, clients and competitors of the firm. They compile all this information into opinions about the prospects for the company's business and stock price. This is known as the "Mosaic Theory". The analysts interface with the buy side's research analysts and PMs; giving them their talking points about different companies. Their recommendation is often boiled down to a buy, hold or sell in the press. The buy side is NOT solely interested in that. They are interested in the thinking process behind an analyst's stock recommendations.

Research salespeople are advocates for their buy side clients. It is their job to obtain the resources needed by them from within the investment bank. This may be a meeting with a sell side analyst or getting them into an industry conference. They market the bank's research capabilities by acting as filters - passing on the most impactful research to a client. For example, if a client has a large position in Microsoft, the salesperson will relay any important research reports regarding that stock to them. A better salesperson may relay news regarding Dell and Hewlett Packard as their sales affect the volume of Windows packages are sold.

Sell side salestraders communicate with the PMs and buy side salestraders. They execute trades and are trying to minimize the transaction prices for the buy side. The calculation of any investment return is dependent on the price of the security when bought. They also act as filters of the investment bank's research. Their ideas are more geared to day trading than any long term investing. Most of the orders are originated by the buy side. At times, they will ask the sell side to facilitate a trade by committing capital. This is something only the largest institutional clients are able to ask for and get.

Position traders interact with the exchanges and salestraders. They have a trading book which has a profit and loss (p/l) statement that is measured constantly. When an order comes from the buy side, the broker/dealer's salestrader will execute the trade through the position trader. Ideally, it will be in the book's current inventory. This is where some friction will appear between the sales and position traders. If the salestrader executes the trade at a good price, the customer will be happy and be more willing to allocate trades to the firm. However, a good price adversely affects the trading book and the p/l statement.

All four roles are large contributors to the broker vote. Whether research or trading is more important is firm specific although each side thinks that they contribute more to the vote than the other. Beyond the client service aspect, there are other items that influence commission allocation such as:

1. Is there is a prime broker relationship?
2. Corporate access
3. Does the investment bank sell the buy side firm's funds?

We will explore these factors later.